The Banana Republic

Do not underestimate how much American spending / economic data is being supported by the defaulters… walk away from your largest debt and your monthly spending can immediately shoot up. Even in some pieces in early 2008, we were writing about how for the first time in US history people were sacrificing their houses rather than their credit cards – a complete sea change to previous periods when the house payment was the one thing people would continue paying no matter what. But when you put almost nothing down into your house (encouraged by policies in the middle part of the decade) – you change people’s behavior.

This is yet another form of “stimulus” – and one not only did we predict it would happen in large amounts because so many are underwater, but I expect the problem to accelerate into 2010. Strategic default is the official name.

Via WSJ:

• Schoolteacher Shana Richey misses the playroom she decorated with Glamour Girl decals for her daughters. Fireman Jay Fernandez misses the custom putting green he installed in his backyard. But ever since they quit paying their mortgages and walked away from their homes, they’ve discovered that giving up on the American dream has its benefits. Both now live on the 3100 block of Club Rancho Drive in Palmdale, where a terrible housing market lets them rent luxurious homes — one with a pool for the kids, the other with a golf-course view — for a fraction of their former monthly payments.
• “It’s just a better life. It really is,” says Ms. Richey. Before defaulting on her mortgage, she owed about $230,000 more than the home was worth.
• People’s increasing willingness to abandon their own piece of America illustrates a paradoxical change wrought by the housing bust: Even as it tarnishes the near-sacred image of home ownership, it might be clearing the way for an economic recovery. Thanks to a rare confluence of factors — mortgages that far exceed home values and bargain-basement rents — a growing number of families are concluding that the new American dream home is a rental.
• Some are leaving behind their homes and mortgages right away, while others are simply halting payments until the bank kicks them out. That’s freeing up cash to use in other ways. Ms. Richey’s family of five used some of the money to buy season tickets to Disneyland, and plans to take a Carnival cruise to Mexico in March. Mr. Fernandez takes his girlfriend out to dinner more frequently. “We’re saving lots of money,” Ms. Richey says.
• The U.S home-ownership rate has charted its biggest decline in more than two decades, falling to 67.6% as of September from a peak of 69.2% in 2004. (the long term range was 65% – and it held steady for decades – until the combination of “easy money” policies by Alan Greenspan and the “ownership society” ethos of the politicians – owning at any cost is more important than being able to actually make payments on what you owe over the long run. And even with all these foreclosures and walk aways, we are still over the long term average) And more renters are on the way: Credit firm Experian and consulting firm Oliver Wyman forecast that “strategic defaults” by homeowners who can afford to pay are likely to exceed one million in 2009, more than four times 2007’s level.

Sounds wonderful so far… more trips to Disneyland, more cruises, more dinners out. We all win here, right?

• Stiffing the bank is bad for peoples’ credit, and bad for banks. Swelling defaults could also mean more losses for taxpayers through bank bailouts.
• Analysts at Deutsche Bank Securities expect 21 million U.S. households to end up owing more on their mIfortgages than their homes are worth by the end of 2010. If one in five of those households defaults, the losses to banks and investors could exceed $400 billion.
• As a proportion of the economy, that’s roughly equivalent to the losses suffered in the savings-and-loan debacle of the late 1980s and early 1990s.

What’s $400 billion among friends? That’s just the Citigroup (C) bailout ($300B) plus an extra $100 billion on top. Money is free in this country and grows on trees. Don’t forget there is another round of fun to happen when all those who are taking FHA loans out now, for 0% down (with use of first time tax ‘credit’ as the down payment) “strategic” default in 2-4 years. And we’ll be told we need to do all the same bailouts, handouts over again because it’s important to support the economy via stealing from future generations so more cruises, dinners out, and trips to Disneyland can happen today.

Now as we mentioned last week, American’s wealth has jumped 5% – part of it through the stock market going up but another part is that debt is falling. [Dec 10, 2009: Americans Net Worth Increases 5% Quarter over Quarter] Why? Well strategic defaults are certainly helping.

• The flip side of those losses, though, is massive debt relief that can help offset the pain of rising unemployment and put cash in consumers’ pockets.

Again, this is the ongoing “stimulus” plan that no one really recognizes. And all it costs is more living standard loss for grandchildren and generations after that.

• For the 4.8 million U.S. households that data provider LPS Applied Analytics estimates haven’t paid their mortgages in at least three months, the added cash flow could amount to about $5 billion a month — an injection that in the long term could be worth more than the tax breaks in the Obama administration’s economic-stimulus package.
• “It’s a stealth stimulus,” says Christopher Thornberg of Beacon Economics, a consulting firm specializing in real estate and the California economy. “The quicker these people shed their debts, the faster the economy is going to heal and move forward again.” (wow, someone’s been reading my blog – I used the exact same words… stealth stimulus)

Back to Ms. Ritchey, our teacher, above… she of big smile in the Wall Street piece. Like many Americans,she was living the good life with nothing down, and using the house at an ATM to get the life “she deserves” with the correct amenities

• In 2004, she and her husband, Timothy, bought a two-story home on Caspian Drive, near Avenue O-8, with a no-down-payment loan. They took pride in the amenities they installed: a powder room with granite countertops, a backyard pool and play area, and the purple-and-turquoise fantasy playroom upstairs for their three daughters.

These are all amenities, as we add them together over millions of households that via bailouts, backstops, incentive programs, and “free money” from the Fed being borne by future generations. This is the connection people who are loving life now are simply not connecting the dots on.

The Ritcheys, received a loan modification which cut their payment, (which the bank was paid for of course via taxpayer money), but it still wasn’t to their liking – so they walked and scoured the neighborhood for an even better house now that they could leave their old house on the roll of the taxpayer.

• “The Richeys turned down the lowest payment we could offer.”
• On one trip, they drove by the house at 3152 Club Rancho Drive. It was bigger than their house on Caspian, had a pool with three waterfalls, and boasted a cascading staircase that Ms. Richey says she could picture her daughters descending on prom night. The rent was $2,195 a month.

You can extrapolate from there with millions of fellow citizens following in these footsteps.

• The situation presented Ms. Richey with a quandary now facing more than 10 million U.S. homeowners who owe more on their mortgages than their houses are worth.

A few people still seem to have old fashioned thoughts on taking on debts… hopefully we can get rid of them for the “betterment” of our economy.

• Tom Sobelman, whose family of four lives across the street from Ms. Richey, at 3127 Club Rancho Drive, sees mortgages as a moral as well as financial obligation. He’s still paying the mortgage on an investment property he owns nearby, despite the fact that the rent is about $1,000 a month short of covering his costs.
• Mr. Sobelman, 37, argues that people who choose to default are unfairly benefiting at the expense of taxpayers, who have put trillions of dollars at risk to bail out struggling banks. “All these people are gaming the system, and I’m paying for it,” he says. “My kids are going to be paying it off.”

Someone who gets it. Thank you Mr. Sobelman.

• Moral or not, the individuals who want to shed their mortgage debts are quickly transforming the Palmdale real-estate market. Adam Robbins, who runs the local Realty World franchise and manages about 80 properties, says about 90% of his prospective tenants are people in Ms. Richey’s situation. So he and other rental managers are loosening rules to accept people who have been through foreclosures.

So now that it has been status quo to “walk away”, credit scores are increasingly meaningless as well. The new Cramerica.

Oh… as for Mrs. Richey, who is employed on the back of the taxpayer as a public employee (via home owner taxes – how ironic)… well she was also a real estate speculator with other properties. You can guess what’s going to happen to *those* obligations.

• She’s also considering walking away from the mortgages on her two rental properties.
• “You take a risk for the American dream,” she says.

What was your risk again? it looks like a heads you win, tails you win proposition – if the property goes up, you use it as an ATM to fund your lifestyle – see your 2004 behavior. If the property goes down, you still win – just walk away and the taxpayers have it covered.
Thankfully with her strategic decisions, she has money to spend on new furniture – luckily her new home already had the granite and pool so no need to spend money on those things again….

• Showing a visitor the personal touches in her new home, including a $1,800 dining set she bought with some of her newly available income…

Fireman Jay Fernandez from the opening of the story? Not to worry folks – he brings down $8000 a month and now that he has walked away, his BMW is secure. I know some readers would not be able to sleep at night if they were not confident that his lifestyle was in good shape.

• With an income of about $8,300 a month and a rent of $2,200, Mr. Fernandez says he now has the wherewithal to do things he couldn’t when he was stretching to pay the mortgage. He recently went to concerts by Rob Thomas and Mat Kearney. He also kept his black BMW 6 Series coupe, which has payments of about $700 a month.

Of course he could have given up the BMW and bought a reasonable car for cash or a low monthly payment and tried to make his mortgage but… that’s for suckers.

So as we celebrate the economic data and talk about how “resilient” the American consumer is (yet again) let us not forget how it is happening. America is now a full blown banana republic.

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